In the early 1990’s, the announcement of NAFTA forever changed the
landscape of the North American Economy. This study analyzes the impact of
this landmark policy decision on the business cycles and output forecast variances
of the United States, Mexico, and Canada, examining these metrics before and
after the NAFTA announcement. This study finds that NAFTA increased trade
and business cycle correlations between all of the countries, with a very
significant increase in the correlation between the United States and Mexico.
This study also performs a forecast variance decomposition analysis and finds
that after the NAFTA announcement, output variance of Mexico and Canada
became more explained by the United States, and less explained by their own
economies. This study places these findings in the conversation of optimal
currency area theory, and suggests that a free trade agreement could be an
effective policy measure for prospective currency union candidates to implement
in advance of forming a currency union.